Microsoft: Will the EU Crack Down?

Gates & Co. face a regulatory pit bull

It was a lesson Bill Gates couldn't miss. Last summer, General Electric Co.'s (GE ) John F. Welch flew to Brussels and lobbied for approval of a deal Washington had already O.K.'d, GE's $42 billion merger with Honeywell International Inc. (HON ) Yet by the time Welch emerged from his meeting with Europe's powerful Commissioner for Competition, Mario Monti, the merger was dead.

Monti has demonstrated that he'll go against Washington, even when American icons are involved. And his next case pits his team of European regulators against a pillar of America's tech economy: Microsoft Corp. (MSFT ) Indeed, just as Washington appears to be heading into the final round of its drawn-out battle with Microsoft, the debate is heating up in Europe, where Microsoft pulls in one-third of its sales. By mid-November, Microsoft attorneys, who dispute the commission's claims, must respond to charges in Brussels that it is abusing its desktop dominance to steamroll a host of competitors in everything from server software to online music.

With the GE-Honeywell case, Monti proved himself a regulatory pit bull. And sources close to the Commission say that he is unlikely to soften his trustbusting to accommodate a world economy unsettled by terrorism and recession. Monti issued his preliminary findings in a confidential document in August and announced that he would "make every effort" to prevent "monopolization through illegal practices." Two days of closed-door hearings are scheduled for December--which means by February, Monti could well be in a position to rule on the case and impose whatever sanctions he deems needed.

So how serious a threat does the software giant face? Chances are Monti will steer clear of Microsoft's nightmare scenario: ordering it to release its precious source code, the digital foundation of its empire. But he could well force Microsoft to rip its Windows Media Player, the heart of its multimedia push, out of the operating system, or hit the company with a big fine.

The Brussels case, which grew largely from a complaint filed by Sun Microsystems Inc., could result in a series of European rulings that rattle the digital world. And by reining in Microsoft, already pushing eagerly into the wireless Internet, Monti could boost Europe's own champions. The most prominent is Finnish phone titan Nokia Corp. (NOK ), which is currently battling Microsoft for control of the software systems that will run the mobile Net.

The American and European cases are similar. Both focus on Microsoft's attempts to leverage its dominance of the desktop into leadership of other markets. But while the American case focused on the browser wars that raged in the mid-'90s, Monti is looking closely at servers. These powerful computers are at the core of Microsoft's .NET strategy, the giant's bid to extend its dominance from PCs to the entire networked world.

Monti's battle could undermine Microsoft's growing clout in the low-end server market and force the giant to unbundle its Media Player from its brand-new Windows XP operating system, scheduled to roll out Oct. 25. "XP is bundling everything imaginable," says Thomas C. Vinje, a partner at Morrison & Foerster in Brussels, which represents the Computer & Communications Industries Assn., a Washington-based industry group battling Microsoft.

In Washington's slow-moving judicial system, Microsoft managed to skirt punishment for six years and is now negotiating a settlement expected to leave its power and wealth largely intact. Europe is a different story. There it faces an army of regulators headed by just one man. Monti, a former economics professor, "is prosecutor, judge, and jury, all wrapped into one," sighs one Brussels lawyer. Since it's a regulatory process, and not a trial, appeals are usually fruitless. This concentrated power makes it harder for Microsoft to wield its most effective Washington weapon: legions of lobbyists.

Lawyers and lobbyists in Brussels are already debating Monti's possible remedies. The most dire possibility--assuming, as nearly all do, that Monti doesn't attempt to break up the company--would be a push to release the source code. But to Microsoft's relief, the words "source code" did not even appear in Monti's statement of objections. What's more, many of Microsoft's competitors lobbying on both sides of the Atlantic aren't calling for a source-code remedy. Why? Microsoft's code is so complex and convoluted that few appear eager to wrestle with it. "It's 30 million lines of spaghetti," says one lobbyist.

A more likely target for Monti is Microsoft's Media Player. In the case, he'll be looking at the connections between this standard feature on the desktop--the very eyes and ears of Microsoft's Web package--and the server software. If he finds that Microsoft uses the Media Player to lock out competitors, from AOL Time Warner to RealNetworks Inc., he could push the software giant to unbundle its player. That would be a severe blow for Microsoft. A softer alternative is also a possibility. Some think he may just force Microsoft to make room for competing media players on Windows.

UNDER WRAPS. Perhaps the least painful remedy, and the most likely, is a push for Microsoft to provide technical information earlier. Competitors complain that the software company keeps under wraps its so-called application programming interfaces, or APIs. These are the digital bridges that permit other companies to link their products with Microsoft's. But rivals say Microsoft often hands that information to its own developers ahead of them. That allows it to get its products to market faster and make its products work better with Windows. If Washington doesn't force Microsoft to provide APIs earlier in the ongoing negotiations, Monti is likely to do so.

While he's at it, he could also pummel Microsoft with a huge fine--up to 10% of annual sales. The money, though, means far less to Microsoft than market dominance. "If I were Microsoft, the fine would be one of the least of my worries," says Stephen Kinsella, managing partner of law firm Herbert Smith's Brussels office.

As it scrambles to put together its own case for the European officials, the software company is still struggling for its bearings in the Brussels bureaucracy. "We haven't figured out how to constructively engage with the commission," says John Frank, Microsoft's director for European law. For now, Microsoft officials deal mostly with mid-level staffers far from Monti's inner circle. Monti may eventually meet with Microsoft Chairman William H. Gates III or CEO Steven A. Ballmer. But that could backfire. GE's Welch, who had envisioned a friendly sales call, instead found himself shouting at the soft-spoken Italian professor, say sources close to the commission. Microsoft can ill-afford a similar blunder. But with its future on the line, the company will likely bring in its big guns soon. Whether that will help, though, is anybody's guess.

By Stephen Baker with Renee Cordes in Brussels, Jim Kerstetter in San Mateo, and Jay Greene in Seattle

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